Financial Stability Review April 2021
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Financial Stability Review APRIL 2021 Financial Stability Review APRIL 2021 Contents Overview 1 1. The Global Financial Environment 5 Box A: The Transition Away from LIBOR 16 2. Household and Business Finances in Australia 23 Box B: Risks in Retail Commercial Property 32 3. The Australian Financial System 37 Box C: What Did 2020 Reveal About Liquidity Challenges Facing Superannuation Funds? 48 4. Domestic Regulatory Developments 53 5. Copyright and Disclaimer Notices 59 The material in this Financial Stability Review was finalised on 8 April 2021 and uses data through to 8 April 2021. The Review is published semiannually and is available on the Reserve Bank's website (www.rba.gov.au). The next Review is due for release on 8 October 2021. For copyright and disclaimer notices relating to data in the Review, see the Bank's website. The graphs in this publication were generated using Mathematica. Financial Stability Review enquiries: Secretary's Department Tel: +61 2 9551 8111 Email: [email protected] ISSN 1449–3896 (Print) ISSN 1449–5260 (Online) © Reserve Bank of Australia 2021 Apart from any use as permitted under the Copyright Act 1968, and the permissions explicitly granted below, all other rights are reserved in all materials contained in this publication. All materials contained in this publication, with the exception of any Excluded Material as defined on the RBA website, are provided under a Creative Commons Attribution 4.0 International License. The materials covered by this licence may be used, reproduced, published, communicated to the public and adapted provided that the RBA is properly attributed in the following manner: Source: Reserve Bank of Australia 2021 OR Source: RBA 2021 For the full copyright and disclaimer provisions which apply to this publication, including those provisions which relate to Excluded Material, see the RBA website. Overview Financial systems globally have been provision balances are expected to be sufficient resilient to a substantial shock to absorb the impact of future defaults. Financial systems in Australia and internationally Globally, ongoing fiscal stimulus, the rollout of have been resilient to the enormous COVID-19 COVID-19 vaccines and very accommodative health and economic shock. This has enabled financial conditions are contributing to the them to cushion the economic impact of the economic recovery that started in the second pandemic, supporting the recovery through half of 2020. There is still substantial new lending and measures such as loan underemployed labour and capital, but the repayment deferrals. The financial sector reforms strong rebound in economic activity greatly that followed the global financial crisis greatly reduces the risk of a sustained deep global contributed to this positive outcome. Banks hold recession that would be very damaging for substantially more high-quality liquid assets and financial institutions. Accommodative financial have much higher levels of capital than a conditions, including policy interest rates that decade ago. Substantial policy support from central banks have committed to keep very low governments, central banks and other regulators for several years, and expectations of a sustained has also underpinned the resilience of the recovery in activity in most economies, have financial system over the past year. Fiscal contributed to rising asset prices, and support has sustained economic activity and indebtedness in some sectors. If risk premiums improved the finances of borrowers, and so loan were to rise from low levels, then long-term performance, and central banks have eased bond yields could jump higher, leading to falls in monetary policy and maintained market a broad range of asset prices that are liquidity in key debt markets. Financial regulators underpinned by the low level of risk-free interest have also employed flexibility in the regulatory rates. framework, for example by providing temporary capital relief if banks extended payment Key risks to financial stability are similar deferrals to customers affected by the in Australia and internationally pandemic. The Australian banks are in a strong financial An incomplete, or very uneven, economic position coming out of the pandemic. Their recovery would present risks to financial stability profitability recovered in the second half of 2020, after banks increased their provisioning for If incomes remain below pre-pandemic levels in expected loan losses in the first half, and analysts some countries, as government support is expect profitability to strengthen further in 2021. wound back, it increases the likelihood that Banks’ non-performing loans have increased, but some borrowers will struggle to make their debt by less than expected, and their current repayments, exhaust their financial buffers and consequently default. Slower growth would also FINANCIAL STABILITY REVIEW – APRIL 2021 1 impede the ability of banks that had low premium is more in line with its value in recent profitability before the pandemic – in particular years. Housing prices in many economies have some in Europe and Japan – to generate new been rising, at a faster pace from the second half capital, and so weigh on their resilience to losses of 2020, which has mitigated the risk earlier in and willingness to lend. Delays in widespread the pandemic that falling prices would result in vaccination, or a reduced efficacy of available significant losses on mortgage lending. In vaccines, are a crucial factor that could stall the Australia, housing prices have recorded strong economic recovery. But even if the recovery in growth in recent months. To date the growth in aggregate activity proceeds broadly as asset prices has not been associated with a expected, an uneven recovery with some parts significant increase in the growth of debt. of the economy continuing to be constrained by However, globally risks associated with asset the virus would still cause significant losses for prices and debt could build. A sustained period lenders exposed to those sectors. of rising asset prices may lead to over- Some emerging market economies (EMEs) are exuberance and extrapolative expectations, with exposed to risk from tightening in financial increased risk-taking and leverage in an conditions in advanced economies, particularly environment of accommodative financial if their own recovery is lagging. Historically, conditions. In this situation lending standards financial dislocation in EMEs has coincided with could weaken, with asset prices being pushed rising global interest rates. In addition, slower above their fundamental values. A correction in rollout of vaccines and pre-existing asset prices, if borrowers’ income were to fall macroeconomic and financial imbalances are and so they defaulted on debt repayments, impeding the recovery in some EMEs, with would expose lenders to large losses on the output not expected to return to pre-pandemic increased debt, particularly if the quality of that levels for several years. These EMEs could then debt had been eroded. face sharp capital outflows, exchange rate The risks are higher from some specific depreciations or unhelpful increases in their leveraged assets. In a number of economies, domestic interest rates. Sharp financial including Australia, housing price growth (and adjustment and disruption in large EMEs could to a lesser extent housing borrowing) has picked also result in losses for exposed investors and up notably in recent months and is being financial institutions in advanced economies. watched closely by regulatory authorities. Globally, the pandemic has accelerated Cyclically low interest rates and rising asset structural change in the retail sector, including prices create a risk of excessive borrowing increasing online sales, leading to falling retail A range of asset prices, both globally and in commercial property prices, while demand for Australia, have been rising – a channel through office property is uncertain given changing work which expansionary monetary policy stimulates practices. The pandemic has also created more economic activity – and some appear high specific challenges for some types of assets. For relative to their expected future stream of example, in Australia, the decline in immigration income. However, for most financial and real and preference changes has introduced assets, this lower rate of expected earnings additional uncertainty for apartment prices, relative to the asset price is broadly consistent particularly in inner city areas. with the very low level of interest rates. For In an environment of accommodative financial example, for equities while the price-earnings conditions with rising asset prices it is ratio is high in some markets, the equity risk particularly important that there is not excessive 2 RESERVE BANK OF AUSTRALIA risk-taking by the financial sector. Increased risk- system or critical nodes. Given this, it is crucial taking by lenders could take the form of looser that financial institutions and systems not only lending standards for individual loan take preventative actions, but enhance resilience assessments, or a relaxation of internal limits on by planning recovery actions to cyber security the share of riskier loans they make. Even if breaches. lenders do not weaken their own settings, increased risk-taking by optimistic borrowers could see a deterioration in the average quality of new lending. This would weaken the resilience of businesses and households, and so the financial system, to future shocks. Increased